The Well That Dried Up

Pittsburgh has weathered some tough economic times and there are
encouraging signs. If only the government weren't broke.

In the heat of an August afternoon in Pittsburgh, construction workers laid shingles and power-washed bricks in a new housing development called Summerset. They were building homes that will sell for as much as half a million dollars, rising up on land reclaimed from Nine Mile Run, a polluted slag heap overlooking the Monongahela River.

It is an impressive project. But as the residents of Summerset move into their new homes, they are discovering that the city won't be controlling rodents or funding community recreation centers. Their property and income taxes--already among the highest in the state--may be increased again. And when the Summerset homeowners drive downtown, they'll have to pay as much as $22 a day to park in a garage.

These are confusing, troubling times in Pittsburgh. In overall terms, the city is doing fairly well. Rebounding from the rapid decline of the steel industry in the 1980s, it has nurtured and created high- paying jobs in the hospital, university and financial sectors. But while Pittsburgh as an economic entity is in reasonably healthy shape, its government is critically ill. Throughout the last decade of relative prosperity, the city's budget ran structural deficits every single year. In the past two years, the budget has collapsed.

In August 2003, Mayor Tom Murphy closed nearly all city swimming pools and recreation centers, cut basic services, increased the parking tax to 50 percent and laid off about 600 municipal workers, including nearly 100 police officers. "This is Pittsburgh's Waterloo," says city controller Tom Flaherty. "It's an abysmal scene here." Two state oversight boards have taken control of the finances and operations, leaving local elected officials nearly powerless.

In June, the city council voted 5-4, amidst great emotional anguish, in favor of a plan drafted by one of the two boards. The plan called for deep cuts in the city budget and a $40 million package of new tax increases. The scene surrounding the council meeting was nothing short of ugly, with protesters taking their fight to the homes and neighborhoods of council members. "It's hard medicine and it is hard to swallow," says Sala Udin, a council member who voted for the plan. "But I think that most of what they recommend and require is a better way of doing business." The tax plan still has to be approved by state legislators, who may or may not be willing to allow the city to raise new revenues.

THE PITTSBURGH PARADOX

It all amounts to a problem that might be described as the Pittsburgh Paradox. And it raises new questions about the whole relationship between economic vitality and fiscal solvency. How does a city with ongoing new construction and ubiquitous help-wanted signs go bankrupt? Is it possible for a government that can't pay its bills even in the best of economic times to turn its budget around in much less favorable circumstances?

In fact, the reasons for Pittsburgh's plight are relatively simple to explain. They lie primarily in the tax structure. More than anything else, it is Pittsburgh's tax system that created the mismatch between its economy and its fiscal health. "The government is starving while the economy is robust," says Udin. "We have made an amazing recovery from the collapse of the steel industry, but city government revenues have not grown as the economy has."

In the 1950s, the city had 600,000 residents. Two out of every three people who worked in Pittsburgh lived there, and 60 percent worked in heavy manufacturing. Today, 600,000 people still come into the city every day. But nearly 300,000 of them live outside its borders, and do not pay its income or property taxes. Pittsburgh's ratio of city jobs to city population is the second-highest in the country (sprawling Atlanta is first). "It's not as if when the people moved out, the jobs moved out," says Harold Miller, president of the Allegheny Conference on Community Development. "The city has the challenge of providing services to people who do not live in the city."

Not only does the tax system fail to reach half of Pittsburgh's daytime population, but the taxes themselves are based on the heavy- industry economy of a half-century ago. There is, for example, a business privilege tax whose collection is crucial to keeping the city solvent. But the state of Pennsylvania has exempted many broad categories of businesses from paying it, including utilities and financial services companies. The result is that 45 percent of Pittsburgh companies pay no business taxes at all. That group includes 44 of the city's top 50 corporations, such as Mellon Bank, Heinz and Alcoa. The city is reluctant to raise tax rates for the remaining small businesses that bear a disproportionate share.

Businesses such as Mellon and Heinz do pay a property tax, but it is based on land use, and today's businesses take up much less land than steel companies did. Even more significant is the fact that the non- profit sector, whose hospitals and universities spurred much of the city's economic renaissance, are exempt from property taxes. If foundations and religious institutions are added into the mix, nearly 40 percent of city land is tax-exempt. When Duquesne University recently turned a private high-rise apartment building into a dorm, for example, the city instantly lost more than $350,000 a year in property taxes. The small commercial revenue base leaves city residents paying the bulk of the property tax bill--at a rate of nearly $3,000 per $100,000 of assessed value.

Pittsburgh citizens also pay a 3 percent income tax to the city and their local school district--the highest in the region. "It doesn't work as a solution to load more taxes on residents," says Jim Roberts, a lawyer who is heading up one of the oversight boards. "It's not fair and it's counterproductive because people will leave." State law has prohibited the city from levying a commuter income tax on its workers and has held an occupational privilege tax paid by all workers to $10 per year since the 1950s.

Pittsburgh's structurally inadequate revenue base has led it to some desperate taxing solutions to capture a part of the cost imposed by its commuting workers. Last year, it had the highest parking tax of any city in the country: 31 percent. Now it has raised that to 50 percent. The parking lot at the city's largest office tower, the U.S. Steel Building, charges $22 per day. The early-bird "special," for those who arrive before 9 a.m., is $15.

OUT OF GIMMICKS

The way Pittsburgh has dealt with its underlying fiscal problem is to balance its budget every year based on one-time tricks and financial manipulations--such as selling its water company to itself. "It's been 25 years of robbing Peter to pay Paul and putting off tough decisions," says Bill Lieberman, chairman of the Intergovernmental Cooperation Authority (ICA), one of the two oversight boards. But last year, after the layoffs and service cutbacks still didn't yield a balanced budget, the city had run out of one-time fixes. "We have no more tricks," says Udin. "We have nothing left to sell. We are honestly broke and we are honestly on the brink of disaster."

The existence of a structural revenue problem is not a revelation to city officials. No less than five independent reports on the city have recommended changes. But state legislators have repeatedly refused to grant new taxing powers until Pittsburgh reduced its expenses. Of those expenses, a sizable portion goes simply to service the city's debt. Pittsburgh currently has more than $935 million in debt, with payments making up nearly 25 percent of its operating budget for 2004. Credit rating companies consider debt at 12 percent of a city's budget to be high; Pittsburgh's debt of $2,800 per capita is the highest in the country.

Some of the debt was unavoidable. For example, the city of 330,000 today is still paying the pension benefits for the city of 600,000 in the 1950s and '60s. In 1998, Pittsburgh borrowed $250 million to shore up its pension fund, which is still only about 50 percent funded. What could have been avoided was making those bonds non-callable, meaning that they cannot be refinanced. In recent months, with interest rates at their lowest point in modern history, Pittsburgh has been legally required to pay its creditors at or above 6.5 percent. The preliminary report of the Intergovernmental Cooperation Authority called the bond financing structure "ill-advised and a tragic error."

Then there are public safety costs, which make up about half of the budget. Here, too, Pittsburgh has incurred expenses beyond those of most other cities, due in part to the political influence of its public employee unions and the state-mandated binding arbitration process. In particular, critics say that spending on the fire department, which comprises more than 40 percent of public safety costs, is overly generous. "We have somewhere in the range of 300 more fire fighters than we need," says Jim Roddey, the former Allegheny County executive. "We have 32 fire stations and we could easily cover with 20. Organized labor is very powerful in Pittsburgh." Fire union president Joe King vigorously disagrees with that assessment, saying that Pittsburgh's geography of numerous rivers and steep mountains makes fire service comparisons with other cities difficult.

Put aside debt service and public safety, and three-quarters of the entire budget is spoken for. Public works, parks and general services all have to be incorporated into the remaining 25 percent. What critics of Mayor Murphy tend to seize on, however, is spending on economic development. In the mid-1990s, Murphy, an unabashed supporter of development incentives, reserved a portion of 1 percent of county sales tax revenues for an economic development fund.

Over the years, that fund has had some visible successes, such as the Summerset residential project, a Home Depot in a depressed neighborhood and a Cheesecake Factory on reclaimed brownfields. But the fund has had equally visible setbacks--most notably the failure of Lazarus-Macy's and Lord & Taylor stores downtown after more than $50 million in combined incentives. The fund began with a $60 million bond issue and receives $6 million per year.

Some legislators and councilmen argue that the fund should be redirected to cover deficits in city operations, but Murphy has been adamant on continuing economic development. "Some people will give me credit for being tenacious and some will criticize me for stubbornness," he says. "We need to have a vision. It's not enough to simply nickel and dime the government."

JUNK STATUS

By November of last year, the city's finances were practically down to nickels and dimes. An audit report from the consulting firm KPMG questioned whether the local government would be able to make it through the year, and publicly raised the possibility of bankruptcy. In response, the three major credit rating agencies lowered Pittsburgh's bond rating to junk status--making Pittsburgh the only major U.S. city in that category.

At that point, after another losing battle with the state legislature over new taxes, Murphy asked that the city be declared distressed under a state law known as Act 47, originally designed to help small cities cope with the loss of the steel industry. The law authorizes new revenue sources for cities, such as commuter taxes, but requires the cities to accept whatever remedies are prescribed by the Act 47 administrators.

The threat of a commuter tax sent suburban legislators scrambling for an oversight board of their own. Hence, the creation of the Intergovernmental Cooperation Authority, under Act 11 of state law. While the Act 47 team is made up of the Pittsburgh law firm of Eckert Seamans and a Philadelphia-based consulting firm, Public Financial Management, the ICA members were directly appointed by legislative leaders.

No other city has ever been under two oversight boards at the same time, and city officials were unsure which group would take precedence if the recommendations differed. In the end, those concerns never materialized. The oversight boards were able to agree on the same set of recommendations--with the Act 47 team releasing theirs in June and the ICA coming out with a similar plan in September. The Act 47 team has focused on the nuts and bolts of reorganizing city services while the ICA has worked primarily on the legislative tax package. When the Act 47 recommendations were unveiled in June, they were greeted by the Pittsburgh Post-Gazette with a headline that said, "Recovery Plan Has Pain for Everyone."

On the spending side, the Act 47 plan is harshest on the fire fighters, who face a 17 percent salary cut, as well as staffing reductions and station closures. With Act 47 status, cities are no longer subject to binding arbitration and can make changes to future labor contracts. For King, the fire president, the Act 47 process has been devastating. "Act 47 is nothing other than a back-door approach to establish a right-to-work state," he says. "What managers weren't successful at in negotiation and arbitration, they are going through the back door to circumvent the rights and privileges of workers."

In addition to the firefighters, all city employees face a two-year wage freeze, the implementation of a 15 percent health premium contribution (employees currently contribute nothing) and the elimination of retiree health benefits. "I think it's an abomination," says Flaherty, the city controller, who believes that more money should have been required of the state and nonprofits. "The city employees took the hit," he says.

Spending cuts in the plan will make up more than half of the city's $70 million deficit for 2004. The Act 47 board has recommended filling the remaining gap with a $40 million tax package that would require approval by the legislature. This would replace the current business taxes with a payroll tax, under which all businesses in the city would pay a specified amount per employee. The plan also would raise the occupational privilege tax from $10 per year to $120 per year, effectively getting some contribution from workers who live outside the city. If the legislature does not go along with some or all of the tax increases, the Act 47 team has a Plan B: Use its power to levy a commuter tax to keep the city afloat. Under that scenario, Pittsburgh residents might also face increased income and property taxes.

The long-term fate of the city is now in the hands of the legislature, which is expected to take up the issue of Pittsburgh's tax package in November. What the tax-averse legislators will do is up in the air. "We're asking for fairness in our tax structure," says Mayor Murphy. "I have always believed that at the end of the day, logic will prevail."